When Should You Fire Your Fund Manager?

Charles Helme |

While you may not think of it in this way, your investment in a mutual fund is actually a contract to hire a professional to manage your funds, just as if you had hired an individual portfolio manager. With investment management fees approaching 1.5%, there’s no need to be concerned if they are being paid enough. The question is whether their pay matches their performance and, at what point should you hand them the pink slip.

We hire mutual fund managers to do one thing and that is to outperform the indexes year-end and year-out. Anything less and we could probably do just as well by investing in an index ETF. So, if a fund manager consistently beat the index by 3 to 4 percent each year, what would it matter if you were paying him 1.5% for the effort? It probably wouldn’t matter, if one could actually do that. The reality is that very few managers achieve that level of performance on a consistent basis.

Every year a small slice of fund managers come out on top of the markets, but that slice has been growing smaller. In recent years as much as 75% of large cap funds have failed to beat the markets over a five year period. That percent grows to 85% of small cap funds. This data does not account for the years in which some fund managers might blow through the index, as many do, or the years in which they get trounced by the index. So, it is possible for a fund manager to fail to beat the market 3 out of 5 years and still generate a better cumulative return.

So, how much should you pay for a fund manager?

Fund managers earn between .5% and 1.0% of the fund’s assets. While you don’t have a say in how much any particular fund manager earns, you do, of course, have a choice in which mutual funds to invest, or fund managers to hire. Not all funds are managed alike, so each must be evaluated based on a number of factors that can influence the fees charged by the manager.

It’s also important to recognize that management fees do vary according to fund activity - small cap funds are more actively managed than large cap; fund size – larger funds require more muscle; fund sector – less populated sectors or niches could command higher fees due to less competition. When considering these factors, it becomes easier to conduct cross comparisons using an apple- to-apples approach. And, it is not always safe to assume that, the lower the management fee, the better.

Certainly a fund manager’s past performance in relation to the indexes is an important gauge to consider. The more important measure is the manager’s performance relative to the indexes in market declines. A manager that consistently outperforms the market in down years can by more valuable over the long term especially when you consider that you are paying that fee whether the market goes up or down.

Don’t forget to include the fund’s other fees, such as administrative and 12b-1 distribution fees in your evaluation. A low management fee may be irrelevant if the fund’s other fees are high. Some funds are better able to control these other costs resulting in a low overall fee. With the vast amount of mutual funds available today, there are plenty solid performers that charge less than 1% as a total annual fee.

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